For many medical students, taking out student loans is well worth the investment. Becoming a physician can have the reward of higher earning potential, and the ability to do something that they would enjoy more than any other occupation. Most medical students rely heavily on student loans to make it through med school. In fact, according to the American Medical Association, in 2011, 86% of graduating medical students graduated with student debt. The average educational debt of these graduates was a staggering $161,290. When residency begins, many of these graduates are faced with tough financial decisions due to their high debt load, low income, and long term financial goals. So how should residents and young physicians tackle this debt load, while saving for their short and long term goals?
Distinguish good loans and bad loans
After you graduate, you will want to separate your loans into two categories, good debt, and bad debt. Bad loans carry high interest rates, and are not deductible on your tax returns. Some examples of bad loans are credit card debt, most auto loans, and unsubsidized student loans. Good loans carry low interest rates, and can be deductible against income. Some examples of good debt are mortgages, and subsidized student loans. Your debt repayment plan should focus on eliminating the highest interest bearing (bad) loans first, and working your way to the lowest interest bearing (good) loans last. For this reason, I typically advise against consolidating loans, because it limits your ability to selectively pay off the “bad” loans, while making minimum payments on the “good” loans. You should also see if it is possible to replace bad debt with good debt. One example of debt replacement is refinancing your mortgage, or taking out a home equity line of credit to pay off credit card debt, or student loans. This is an effective way to transform bad debt into good debt. Utilizing these strategies can end up saving you thousands of dollars in interest or lower taxes over the course of the loans.
Set up a debt repayment plan that you can manage
After graduation, Residents can expect to earn somewhere between $40,000 and $50,000 per year during their first year. Because of the high loan to income ratio, many residents find it difficult to pay down their loan balance during residency (and rightfully so). Below are some options for student debt repayment plans.
The standard repayment plan for student loans is the 10 year repayment plan. Assuming a student loan of $161,290 (average educational debt of med grads), and a 6.8% interest rate (standard interest rate for federal loans), the monthly payment under a 10 year plan is $1,856/month or $22,272/year, representing roughly 50% of their pre-tax salary. Many residents simply cannot afford to make the minimum payments on a 10 year loan repayment plan. This payment plan may be suitable for residents with a low amount of debt, or income from another source (spouse, investments). For residents that have a high amount of debt, and modest income, there are more flexible options available.A 25 year extended repayment plan will extend the term of the loan to 25 years, which will reduce the payments considerably. In the above example, the monthly payment for this plan would be $1,120, or about $13,440/year. Note that the longer the repayment period, the more interest you will pay over the course of the loan. For some residents, this monthly payment may still be too burdensome to maintain their lifestyle.
Many residents, who cannot afford a fixed repayment plan, choose to utilize an income based repayment plan. This payment plan uses a formula based on your current income which caps your minimum payment to 15% of your discretionary income, which is typically lower than the fixed term repayment plans. Although you must initially sign up for 25-year income-based or income-contingent repayment, you are not locked into this payment plan. If your circumstances change or if you just decide that you want to pay off your loan more rapidly, you may do so. Enrolling in an income based repayment plan could also allow for debt forgiveness for direct loans. Making income based repayments will allow discharge of the remaining debt after 25 years of payments. Note that each payment must be made on time to be eligible for loan forgiveness.
For public service workers, debt will be forgiven after 10 years of repayments. In order to have debt forgiven, you need to work full time for a qualified employer, and make all of your payments on time. Qualifying employment is any employment with a federal, state, or local government agency, entity, or organization or a non-profit organization that has been designated as tax-exempt by the Internal Revenue Service (IRS) under Section 501(c)(3) of the Internal Revenue Code (IRC). The type or nature of employment with the organization does not matter for loan forgiveness purposes. Additionally, the type of services that these public service organizations provide does not matter for loan forgiveness purposes.
For many residents, income based repayment will provide the most flexibility, but comes with some disadvantages. Because the minimum payment is based on your income, you will need to submit paperwork every year to determine your minimum payment based on that years income. Also, making the minimum loan payment will result in paying more interest over time. Because income for many doctors will significantly increase after residency, so will the minimum payments, making it unlikely to carry a loan balance after 25 years of repayment, meaning many doctors under this repayment plan will be unable to take advantage of the debt forgiveness program unless they are a public service worker. Also, if you debt is forgiven, you will have to pay income tax on the amount of forgiven debt. The income based repayment plan may be suitable for residents that cannot afford the minimum payments of the standard and extended repayment options, especially if their career choice is in the public service area.
Seek Personalized Advice
Because every situation is unique, and not all loans qualify for every repayment plan option, it is recommended that you seek customized advice for a debt repayment plan. If you are looking for personalized financial advice, you should be looking for a professional with the education, experience, and ethics of a Certified Financial Planner, or CFP®.
– Adam Glassberg CFP®, CIMA®